9.1. Money markets

Question 1

Cash deposits:

Answer 1

• Call
• Notice
• Fixed/term

Question 2

Examples of MM instruments

Answer 2

 T-bills
 Certificates of deposit
 Commercial paper
 Bills of exchange

Question 3

SYSTEM T

Answer 3

Security
Depends on issuer, but generally good. Generally high due to short term and rare defaults

Yield

• Related to short term interest rates.
• Generally real since short term interest rates vary with inflation.
• Close to risk free&raquo_space;> low returns
• Running yield is roughly equivalent to govt bonds, but higher than equities

Spread
- Little capital value volatility; change in interest rates&raquo_space;> low impact on price

Term
- 1 day (overnight) to 1 year
Expenses + Exchange rate
- Minimal; Available in foreign currencies

Marketability

• Good [except for call/term deposits]
• Unquoted and traded through interbank money market

Tax
- Taxed as income [because of short term]

Question 4

Attraction of cash due to liquidity

Answer 4

• Known short term commitments
• Uncertain outgo
• Opportunities
• Received recent cash flow
• Nominal capital value preservation & risk aversion (inflation protection)

Question 5

Attraction of cash due to a change in economic scenarios

Answer 5

• Rising interest rates
• Start of economic recession
• Domestic currency depreciation
• Economic uncertainty

Question 6

Key players

Answer 6

• Central banks
• Clearing banks
• Other institutions

Question 7

Clearing banks

Answer 7

• Lend excess liquid funds and borrow when they need short term funds
• Loans usually overnight
• Interbank rates used as benchmark for interest rates

Question 8

Central banks

Answer 8

• Lender of last resort
• Provide liquidity to banks when required
• Use operations in MM to establish short-term interest rates
• Operations: sale/purchase of T + other eligible bills

Question 9

Rising interest rates

Answer 9

• Bond prices fall due to higher GRY
• Depress equity valuations
• Depress economic activity&raquo_space;> fall in equity markets
• Interest rates have low impact on MM&raquo_space;> protected in times of falling bond and equity prices

Question 10

Start of economic recession

Answer 10

• Domestic economy likely to perform badly
• Govt likely to increase borrowing&raquo_space;> increasing supply = prices falling
• However, short term interest rates may be raised after recession&raquo_space;> inflating bond market
• Cash more attractive

Question 11

Domestic currency depreciation

Answer 11

1. Short term interest rates may be raised to defend domestic currency = cash more attractive as other asset values fall
2. Stronger foreign currency&raquo_space;> overseas cash investment attractive = value in domestic currency of overseas cash would increase